Credit Analysis| Four Early Warning Signs Of Public Company Credit Risk Deterioration

A firm’s stock price is often thought to be a reflection of its expected future cash flow. Based on this idea, in 1974 Merton proposed a model for assessing the structural credit risk of a company,1) leveraging Black-Scholes’ options pricing paper. 2) This model has become popular among financial and academic practitioners and is still employed to monitor the credit risk of public companies or for investment purposes.

Due to its market-driven nature, the model’s daily outputs are often plagued by unwanted noise that makes it hard to detect genuine signs of a firm’s impending credit risk deterioration.

At S&P Global Market Intelligence, we have developed PD Model Market Signals (PDMS), a statistical model that builds on the original framework proposed by Merton with further enhancements and refinements such as…